Bears dominate emerging markets as central banks battle Omicron

(Bloomberg) – If emerging market central banks struggled to consolidate their currencies as the Federal Reserve stepped up its cuts in monetary stimulus, their task became much more difficult.

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Concerns over the emergence of the omicron Covid-19 variant caused risk assets to plummet on Friday, tipping MSCI Inc.’s developing country currency gauge into deficit for the year and potentially on track for its first annual decline in three years.

Central banks in developing countries were weakened by renewed dollar strength long before omicron’s identification, with tightening policy from South Korea to Russia and Brazil doing little to stem the exchange losses that are fueling inflation. The biggest losers this month are the Mexican peso, South African rand and Hungarian forint, all currencies of countries that raised interest rates in November. This puts bearish investors in the ascendancy.

“All the factors that limit visibility make life more difficult for central banks,” said Viktor Szabo, investment manager at abrdn plc in London. “But a growing number of central banks in emerging markets are starting to realize that the question of whether inflation is transient or not is not really relevant at this point. Inflation is high and persistent, although it is mainly caused by supply-side shocks, and can de-anchor inflation expectations and put pressure on currencies. “

EM weekly podcast: Omicron variant; China PMI; Inflation in Mexico

The threat of a more serious variant could also push key policymakers in mature markets, such as the Fed and the European Central Bank, to become more accommodating, which could offset the need for more aggressive tightening in developing countries. development, said Olga Yangol, director of emerging markets strategy at Crédit Agricole SA in New York.

“The variant could indeed hit emerging markets harder than other assets, especially high beta currencies from Latin America and South Asia which are more sensitive to risk sentiment and more exposed to energy.” and tourism, the sectors most affected by the pandemic, “she said.

“Punished by the markets”

Political interference did not help. Turkish President Recep Tayyip Erdogan’s campaign for a rate cut caused the pound to fall last week. The currency extended its decline on Monday after Erdogan said he would never advocate for an interest rate hike. Friday’s data will likely show the country’s inflation topped 20% in November.

The Mexican peso fell last week as President Andres Manuel Lopez Obrador’s appointment of a little-known finance ministry official to head Banxico fueled concerns over possible government interference in the independence of the central bank.

“Any sign of government interference in monetary policy will be immediately punished by the markets as long as the global monetary headwinds harden,” said Witold Bahrke, Copenhagen-based senior macro-strategist at Nordea Investment. “While the main reason we are underweight emerging market currencies is tighter global monetary conditions, this reinforces the bearish case for the market.”

The correlation between emerging market currencies and short-term Treasuries is near the highest level since 2014, highlighting the potential fallout from rising US interest rates. Investors are hedging against the risk of larger price swings as the dollar hit its highest level since July 2020. JPMorgan Chase & Co.’s implied volatility gauge in developing currencies last week exceeded 10%. % for the first time since April.

Real rates – which exclude inflation – in most developing economies remain below zero, even after a tightening. This lessens the attractiveness of emerging market assets as US yields rise and concerns about the sustainability of the recovery in developing economies intensify. Investors will get more clues about the health of emerging markets in the coming days, with the release of official Chinese purchasing managers indices and expected gross domestic product figures from Turkey to India and Brazil.

Political dilemma

Hungary, which had followed its central European counterparts the Czech Republic and Poland on a path to tighten policy, on Thursday made its third interest rate hike in two weeks, but failed successfully prevented the forint from falling to an all-time high. Meanwhile, Brazil’s central bank president Roberto Campos Neto, who has chaired the world’s most aggressive tightening cycle this year, on Wednesday warned against raising interest rates too quickly despite his concerns. concerning inflation above the target.

The real is down more than 7% this year despite a 575 basis point rate hike by the central bank, which also signaled another 150 basis point hike in prospect next month. Political and fiscal risks led traders to ignore Selic’s increases.

“We expect currencies to remain under pressure until the end of the year and possibly early 2022,” said Paul Greer, a London-based fund manager at Fidelity International, whose debt fund developing countries outperformed 94% of its peers this year. “It is currently difficult for emerging market currencies to compete with the US dollar. “

Here are the events and data to watch this week:

  • China’s manufacturing PMIs expected on Tuesday will likely show the economy to stabilize in November as pressures from Covid outbreaks and power shortages ease. Even so, the gauges will signal an anemic pace of growth, underscoring the need for policymakers to cushion the downturn in the economy, according to Bloomberg Economics.

  • November inflation in South Korea is expected to decline from the previous month

  • Turkey’s third quarter gross domestic product figures on Tuesday could show the economy is past its pre-pandemic peak

  • Kenya is set to keep its key interest rate at 7% on Monday after inflation unexpectedly slowed for the first time in six months in October

  • Traders will watch the Mexican central bank’s quarterly inflation report on Wednesday for clues to the direction of monetary policy

  • Brazil will also offer a wealth of economic data, with September unemployment figures expected for Tuesday, third-quarter GDP on Thursday and industrial production for October on Friday.

(Add Erdogan’s comments and economists’ forecasts for inflation in Turkey in seventh paragraph)

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